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Workplace Retirement Plan Options for Entrepreneurs

When you are starting a business, what retirement plan options do you have?

By Stacy Miller, CFP

Embarking on the journey of entrepreneurship and small business ownership can be frightening. You often give up the security of regular income and benefits in the hope of a fulfilling, flexible, and prosperous new career. Some prospective and new entrepreneurs overlook the long-term effects of that leap. What happens to your future retirement plans when you stop contributing to a workplace retirement plan, and what solutions are there for these entrepreneurs?

Stacy Miller

Stacy Miller

Consider Olivia, a 30-year-old who has contributed to her workplace retirement plan at the rate of $10,000/year for the last eight years. Let’s assume that she has earned an average annual return of 5%. The value in her account today is $95,491.09.

Now, Olivia has quit her job, stopped contributing to that workplace retirement plan, and is starting her own business in the hope of achieving success and work-life balance goals. Assuming an average annual return of 5%, that workplace retirement plan will be worth $526,730.32 when she is 65; a nice nest egg because she was diligent as a young professional, and those investments had decades to grow and compound. Unfortunately, that nest egg will not be enough to sustain Olivia for the decades she will live beyond age 65. She will need to continue to contribute toward her retirement as an entrepreneur. Vitally important are these early years that will have decades to compound.

There are several options for entrepreneurs like Olivia to continue to contribute towards their retirement plans:

  • Traditional IRA: An entrepreneur can contribute up to $6,000 ($7,000 if over 50 years old) if she has income over $6,000, or if her spouse has income. This is tax deductible within income limits. Taxes are deferred until withdrawal after age 59 ½. 
  • Roth IRA: An entrepreneur can contribute up to $6,000 ($7,000 if over 50 years old) if she has income over $6,000, or if her spouse has income. Contributions have annual income limits. These withdrawals are tax-free after age 59 ½. 
  • SEP IRA: An entrepreneur (sole proprietor or small business owner) can establish this workplace retirement plan into which the business may contribute (there is no employee deferral) a maximum annual contribution of the lesser of $58,000 (for 2021) or 25% of compensation (up to $290,000). Of the entrepreneur workplace retirement plans, this is the easiest to setup and manage, as well as the most flexible. Taxes are deferred until withdrawal after age 59 ½. 
  • SIMPLE IRA: An entrepreneur with a small business (under 100 employees) can establish this workplace retirement plan into which the business must contribute to all eligible employees. Employees may defer up to $13,500 annually (for 2021; $16,500 if over 50 years old). This workplace retirement plan is also relatively easy to setup and manage. Taxes are deferred until withdrawal after age 59 ½. 
  • Individual(k) or Solo 401(k): This workplace retirement plan works exactly like the traditional 401(k) except this is only for when the business owner is the only employee. Contributions can be made as both an employee (deferral up to 100% compensation, up to $19,500 in 2021, $26,000 if over age 50) and as employer (25% of compensation, up to a combined $58,000). This plan requires more setup and administration and therefore, fees, but allows for the maximum contributions for the sole owner.

If Olivia has a five-year gap in contributing towards her retirement and her future financial security, how much of a difference would it really make? An investment of $6,000 each year for those five years, assuming an average annual return of 5% for those five years as well as the next 30, Olivia would have missed out on $541,921.84 at retirement!

Olivia, however, had this information from her financial planner and was able to continue to contribute towards her future financial security. She initially contributed to her Roth IRA in those lower income, early entrepreneur years, and then established an Individual (k) once her business took off. She was able to successfully navigate the switch from traditional employee to entrepreneur without missing out on years (and decades) of compounding interest and returns.

Based on her early retirement contributions and the wonders of compounding, she’s heading toward being a millionaire at retirement, and because of all the opportunities for her to continue to contribute as an entrepreneur, she’s well on her way to enjoying future financial security, no matter how she might define that.

About the author: Stacy Miller, CFP®

Stacy Miller is a CERTIFIED FINANCIAL PLANNER™ professional and partner with Bright Investments, LLC. She is a fee-only fiduciary wealth advisor and member of the Financial Planning Association (FPA) and the National Association of Personal Financial Advisors (NAPFA). Stacy has been featured in CNBC, Money Magazine, InvestmentNews, HerMoney, and more. She is an expert in helping women find financial security through transitions, crises, and windfalls.